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Bangladesh, Cheap Production, and Worker Safety: The Cost of Externalities

The online petitions are multiplying as consumers worldwide
react with shock and horror to last month's deaths of more than
1,100 garment workers in Bangladesh toiling in conditions that
might have made a Victorian-era chronicler cringe. Several of the
world's largest retailers - at least, those of them that happen to
be based in Europe - have lined up to sign a legally binding
agreement to underwrite the cost of bringing other such factories
up to an acceptable workplace standard, and to oversee those
repairs and monitor working conditions on an ongoing basis.

For now, let's work on the assumption that companies like
H&M
(OTCMKTS:HNNMY), Primark, and the Dutch chain C&A are motivated
by the same kind of distress that you and I feel when we see the
images from Dhaka's collapsed Rana Plaza building or read reports
of working conditions there. Give them credit - rightly or wrongly
- for being motivated by a desire to ensure that such a catastrophe
never happens again and not by fear that consumers will realize
that their suppliers worked in buildings like Rana Plaza - or
others not too dissimilar throughout Southeast Asia and other
garment industry hubs - paying employees a minimum wage of $37 per
month.

Even so, the face-off between activists and socially responsible
investors on the one hand and companies like
Wal-Mart Stores
(
WMT
) and
Gap
(
GPS
) (both of which chose not to go along with the legally binding
pact among retailers) sheds new light on a problem that has
bedeviled thousands of other publicly traded companies over the
decades: how to deal with what are known as "externalities."

An externality, in the jargon of economists, is what happens when a
company makes a business decision that has positive or negative
consequences for the broader world. A company that pollutes, for
instance, is creating a negative externality for those that live
near the plant that is destroying the air quality or that draws
water from the sources that have been contaminated by its mining
operations, for instance. A company that voluntarily takes on extra
safety costs that exceed the standards its competitors adhere to or
that underwrites the cost of education and training for its
workforce when its rivals don't, is an example of the flip side of
the coin.

Companies can't avoid wrestling with externalities. All of them
walk a more or less narrow line, trying to understand when the cost
of preventing a negative "externality" is worth whatever
consequences follow in its wake. Regulation is one issue that can
affect the decisions they make: The rise of environmentalism and
the creation of the Environmental Protection Agency in 1970 made
the consequences of polluting potentially more serious; companies
trying to balance the costs to themselves of polluting or paying to
dispose of their waste in a less harmful way suddenly found the
playing field tilted in favor of the latter. In other cases, social
trends and consumer choices play a similar role; this time, there's
a carrot rather than a stick at play.

A publicly traded company like Wal-Mart or Gap Stores has a
fiduciary duty to its shareholders to maximize its returns. The
events in Bangladesh have highlighted a giant conundrum for them -
one that even before the collapse of the Rana Plaza they
undoubtedly wrestled with. Clearly, apparel retailers have been
eager to move their facilities from one country to another: as
wages and thus production costs climbed in China, to keep the
prices of their t-shirts and jeans stable and competitive in North
America and Europe, they shifted operations to Cambodia and
Bangladesh. To the extent that they know that being too insistent -
or more insistent than their peers -- on questions of safety, child
labor, or living wages will mean higher costs and lower profit
margins, it always has been easier to try to avoid knowing about
some of these issues.

Will anything really change now that the true cost of all our
inexpensive t-shirts - externalities included - has been made so
dramatically apparent? Real change will require more than petitions
and pacts. It will demand virtual unanimity on the part of
consumers - each of us being willing to pay more for the clothes we
buy, reflecting the higher costs associated with those higher
manufacturing standards. The reason that apparel manufacturing was
shifted offshore, and then to increasingly low-wage countries like
Bangladesh, is that we demonstrated that we weren't following
through when it counted most: when we went shopping. We can't just
tell companies like the Gap that we won't buy garments with such a
high non-financial price tag associated with them; we have to
demonstrate our willingness to do so, over and over again. Those
companies need to be convinced that if they don't take a hit on
profit margins or costs, they will take an even bigger one on
sales.

Wal-Mart has decided not to sign on to the European plan, and
instead intends to hire an outside auditing firm to inspect the
Bangladeshi factories that produce garments for sale in its stores.
We'll be able to inspect the results - posted on its website - by
June 1, and the company has said it will insist that factory owners
undertake work to remedy any safety issues at their own expense, or
face the prospect of being cut from the list of Wal-Mart suppliers.
(Wal-Mart acknowledges that these renovations may show up in higher
costs.) Here we have the whole conundrum in one example. Do we -
and does Wal-Mart - believe that an outside firm can do a thorough
and accurate job inspecting nearly 300 separate facilities in the
next two weeks? Given that whistleblowers report violations that
inspectors routinely miss even in North America, I'm skeptical.

Then there is the question of Wal-Mart's request to companies
falling short of their standard to remedy the matter. In what time
frame? Who will judge that it is done adequately, and that this is
a sustained effort? And while Wal-Mart says a company may be axed
from its supplier list for not complying, it doesn't say that this
will be automatic. And what happens down the line, when Wal-Mart
realizes that because of those renovations, their supplier is no
longer the lowest-cost producer? Will it switch to a cheaper
provider - and will that provider be held to the same high
standard?

It boils down to the willingness of companies like Wal-Mart to
accept the possibility of lower margins, and to the willingness of
consumers to pay higher prices. And for all these well-intentioned
petitions to work, everyone needs to be on the same page. There
can't be any incentive for Wal-Mart to move to another, lower-cost
jurisdiction, or any ability for a supplier whose safety and
employment standards are subpar to play one European retailer in
search of lower costs against another.

The same is true at the consumer end of the spectrum. When Wal-Mart
released its earnings this week, the company's chief financial
officer described its consumers as being financially "stretched" in
his effort to explain why same-store sales slid 1.4% in the
company's first quarter. At Gap, whose stock price has soared this
year, one of the segments that has led sales growth has been Old
Navy, the division dedicated to making the cheapest possible
versions of styles seen elsewhere. A month ago, a cheaper version
of a maxi dress being sold for about $75 at Gap was spotted on the
racks at Old Navy for $30 - marked down to $15.

This is a difficult and emotionally charged issue - but while the
cost in human lives in Bangladesh is dramatic, the issue itself is
far from new. Over and over again, enough North American consumers
have demonstrated their ability to shove to the back of their minds
the working conditions of those who make the t-shirts they buy in
countries they likely will never visit that it has been possible
for retailers to view insisting on real and lasting improvements in
working conditions in those countries as an overly costly
externality. Only a years-long effort and the willingness to change
our consumption habits will force a real change in corporate
behavior.

Editor's Note: This article by Suzanne McGee originally
appeared on
The Fiscal
Times.

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